Can an Inheritance Do More Harm Than Good?

By Catey Hill

With the end of the year approaching, and the possibility of further changes in the federal estate tax looming, many families have inheritances and legacies on their mind. And among well-off boomers, the idea of providing something for their heirs remains a strong motivator. Fifty-five percent of boomers with $3 million or more in investable assets consider it important to leave their kids a financial inheritance, according to most recent U.S. Trust Insights on Wealth and Worth study.

That’s a nice sentiment, for sure. But many advisers and wealth managers argue that leaving an inheritance, if not done right, can do more harm than good. “Even a responsible kid might not be able to handle an inheritance,” says attorney Richard Watts, the founder and president of Family Business Office, a legal and consulting firm, and author of Fables of Fortune: What Rich People Have That You Don’t Want.

We’ve all heard a horror story or two about the kid who blew through his inheritance via a series of hot cars, fancy vacations and misguided investments. And of course, the financial-services industry benefits from stories like this, since firms can earn good money by signing on to steer your future heirs out of trouble.

Still, there are plenty of legitimate pitfalls that go with inheriting money. An inheritance “might affect [someone’s] willingness to work hard or go to school,” says Andrew Aran, a partner at Regency Wealth Management in Midland Park, New Jersey. It can leave someone’s children “more subject to bad influences” who are looking to get their hands on some of the money, says Tracy Craig, a partner and chair of Mirick O’Connell’s Trust and Estates group in Boston. And it can rob them of self-fulfillment, says Watts. “When you give kids a lot of money, you take away some of the struggle,” he says. “Kids don’t get a feel for who they are.”

That said, inheriting money can help children further their education, buy a home and provide for their own families. “I can’t think of an instance [where you’d want] to cut someone off, unless you are estranged from a child,” says Carrie Schwab-Pomerantz, president of the Charles Schwab Foundation, a non-profit focused on financial education, philanthropy, and volunteerism; even then, you might want to use the inheritance as a “starting point for making amends,” she adds.

So, for those in the I-want-to-leave-an-inheritance group, the pros recommend a few steps that can help keep things from going awry.

To begin with, parents ought to consider whether their kids are mature and responsible enough to handle an inheritance. “Give them some money while you are still alive and watch what they do with it,” recommends Aran. “Do they learn from their mistakes with it, or do they not?”

Parents might consider putting some limits on an inheritance. Some create trusts that specify that the money be used only for education, health and maintenance, says Schwab-Pomerantz. She recommends that parents not make the terms of a trust too strict: “Make it general enough to allow kids leeway to grow their life.”

Parents with younger or less mature kids should also take their children’s age into account –for example, by creating a trust that staggers the ages at which children receive the money, says Fletcher Findley, a co-founding attorney at estate planning firm Findley & Rogers in Seattle. A parent could dictate that the child gets payments at ages 25, 35 and 45, rather than all at once. Another option: appointing a trustee to keep an eye on things until the children reach a certain age.

Parents also need to consider whether a child might have addiction or psychological problems that would impair her ability to deal with the money. While this seems like a no-brainer, “sometimes these issues aren’t apparent until the late 20s or 30s,” says Craig.

Finally, would-be benefactors should realize that “children don’t have a right to an inheritance,” says Craig. Sometimes, adds Watts, it’s better to “give them a little when you are living, and less when you die.”

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About Encore

Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.